JPMorgan Guilty Plea Sought by Holder Shows Harder Stance

By Tom Schoenberg -
Oct 22, 2013

JPMorgan Chase & Co. (JPM) Chief Executive Officer Jamie Dimon went to Washington almost a month ago to see if U.S. Attorney General Eric Holder would settle a criminal probe of mortgage fraud at the bank if it paid more money to resolve related civil investigations.

Holder’s team, which included Deputy Attorney General James Cole and Associate Attorney General Tony West, said ending the investigation by the U.S. attorney in Sacramento would require the bank to plead guilty to something, according to a person familiar with the talks, which were held in a conference room that was Robert F. Kennedy’s office when he had Holder’s job.

Later, the department proposed the bank plead guilty to making false statements related to sales of toxic mortgage bonds. The bank proposed a nonprosecution agreement, which Holder rejected, the person said. The bank agreed to assist the continuing criminal probe. The negotiation typifies the harder line the Obama administration is taking in its second term.

Holder, 62, in an interview with Bloomberg News about the department’s new aggressiveness on bank probes, said: “It was clearly a priority for the president, it was a priority for me and for this Justice Department. One look at the magnitude of harm and the number of people suffering as a result of these acts that we’re looking into made sense to me that my personal involvement was needed.”

Holder, a Columbia University law school graduate who has spent much of his career at the department, gave the interview just a few hours before he and Dimon agreed Oct. 18 to an outline of a record $13 billion accord to resolve the civil investigations.

Extracting Penalties

Holder’s refusal to let JPMorgan, the biggest U.S. bank, escape criminal liability for its mortgage-bond sales, and the move to extract penalties for wrongdoing that led to the financial crisis, may go a long way toward appeasing critics of the Justice Department who have been urging charges against bankers since the collapse of Lehman Brothers Holdings Inc. in 2008.

Joe Evangelisti, a spokesman for the New York-based bank, declined to comment on the talks.

The harder line began on orders from President Barack Obama. He promised in his 2012 State of the Union address to hold banks accountable for their role in helping trigger the deepest recession since the Great Depression. A mortgage task force of prosecutors and regulators set up to carry out the president’s mandate produced the $13 billion deal, which requires a formal sign-off by both sides

Settlement Terms

The proposed settlement will subsume the Sacramento U.S. attorney’s civil probe, as well as that of federal prosecutors in Philadelphia investigating matters related to Washington Mutual Inc., the person said. The deal would also end a probe of Bear Stearns Cos.-related wrongdoing by the Justice Department’s Washington headquarters. JPMorgan took over operations of both banks during the financial crisis.

The accord would include $4 billion in relief for consumers hit hardest by the housing downturn in regions where JPMorgan has branches, and $9 billion that includes fines and other payments, another person familiar with the matter said.

JPMorgan won’t be penalized for wrongdoing tied to Bear Stearns and WaMu, the person said. Rather, the portions of the settlement related to those institutions will be compensatory.

The penalty portion, a little less than a third of the $9 billion, would be related to JPMorgan legacy loans, the person said. The deal will also include about $3 billion for states and federal regulators, much of which may be passed on to investors who bought faulty mortgage-backed securities, according to two people briefed on the matter.

Taking Shape

The first indications that the department’s long criticized efforts were taking shape surfaced in three places. Bank of America Corp. was sued in federal court in Charlotte, North Carolina, on Aug. 6, accused of misleading investors about the quality of loans in $850 million in bond deals.

Two days later, JPMorgan disclosed that it was being civilly and criminally investigated by the U.S. attorney in Sacramento, the criminal probe Dimon and his general counsel, Stephen Cutler, were trying to end in the Sept. 26 talk with Holder, and a lawsuit against Clayton Holdings LLC, Wall Street’s largest due diligence firm, was filed that month, producing a U.S. demand for a turnover of massive amounts of documents about financial clients.

At an Oct. 3 hearing in U.S. District Court in Hartford, Connecticut, three days into the government shutdown that halted federal lawsuits nationwide, Assistant U.S. Attorney Edward Newman complained Clayton was trying to “saw the legs off” of the Justice Department’s probe into mortgage bond sales by refusing to turn over e-mail and client reports covering a three-year period.

Cooperative Arrangement

For Clayton’s lawyer Marc Rothenberg, it was a shift in tone from a more cooperative arrangement over six years during which prosecutors sought information from his client on a case-by-case basis. As he explained it to the judge in charge of the case, he was suddenly being told by the government: “We want it all, and we want it now.”

Rothenberg said 16 banks were on a list of targets the government gave his client in June. The department is focusing on about half of them, according to a person familiar with the matter. Rothenberg and the government refused to publicly identify the banks.

“There will either be cases announced or resolutions announced, I just don’t know which they will be,” West, who oversees the group devoted to probing the sale of residential mortgage-backed securities, said in an interview at the Justice Department’s headquarters last week.

Task Force

West, who wouldn’t speak specifically about any of the department’s continuing probes, explained how the task force developed its plans to bring cases stemming from the financial crisis -- and what banks might expect in the future.

“You’re seeing some of those results peek through the surface now,” West said.

William Black, who served as deputy director of the Federal Savings and Loan Insurance Corp. during the S&L crisis of the 1980s, said the department’s actions haven’t convinced him that bank executives will ever be charged.

“So, the large story remains,” Black said in an e-mail. “No prosecutions under Bush and the first five years of Obama of the elite bank frauds that drove the crisis.”

The demand for a record-setting settlement from JPMorgan has put Holder, the subject of continued attacks from Republicans in Congress since becoming attorney general in February 2009, on the offensive.

Congressional Backlash

Holder, a former District of Columbia Superior Court judge and ex-U.S. attorney in Washington, sparked a Congressional backlash that defeated his plan to try Khalid Sheikh Mohammed, accused of planning the Sept. 11, 2001, terrorist attacks that killed almost 3,000 people in Manhattan, Virginia and Pennsylvania, in a civilian court.

Holder was sued by a Republican-controlled House committee to enforce a subpoena for its inquiry into Operation Fast and Furious, a department probe that allowed illegal gun purchases in the U.S in an effort to link the weapons to Mexican gangs.

Citing executive privilege, the attorney general has refused to give lawmakers some material they wanted.

He has also come under fire from conservative groups for dropping the government’s case in the Defense of Marriage Act.

Holder’s role in leading the effort by the Obama administration to intensify scrutiny of financial institutions for wrongdoing tied to the 2008 economic meltdown may help change the conversation about his tenure.

“He doesn’t want to see his legacy be that of the attorney general who saw banks as too big to fail,” John Coffee, a professor of law at Columbia University, said.

Sticking Points

The U.S. plans to use the proposed JPMorgan pact as a model as it seeks other bank accords, using a hybrid of consumer relief and penalties, said the person familiar with the matter.

Of the $4 billion in relief included in the settlement, Detroit, which this year filed the biggest municipal bankruptcy in U.S. history, will probably get a big portion, the person said. Dimon responded favorably to that aspect of the proposed deal, noting JPMorgan had the biggest bank presence in that city, the person said.

The remaining sticking points to the deal include how the consumer mortgage relief will be structured, the person said.

Pre-Value Principal

The U.S. is demanding pre-value principal write-downs as opposed to coupons, said the person, with funds to be specifically focused on the hardest hit metropolitan areas.

The most difficult task remaining is the wording of the statement of facts, the person said, in terms of what conduct JPMorgan admits to. Justice Department officials want the bank to admit to all of the allegations in the draft complaint drawn up by the Sacramento U.S. attorney, the person said.

Some parts of the agreement might not be concluded by the time a deal is unveiled, two people said.

The $3 billion investor portion will be split between California Attorney General Kamala Harris, New York Attorney General Eric Schneiderman, the Federal Deposit Insurance Corp., National Credit Union Administration and possibly another state, the people said. New York will receive about $500 million and will probably use it to reimburse investors, they said.

The formal releases from civil liability will take several weeks, another person said, as each of the affected jurisdictions must write up their portion.

The Group

The RMBS group -- made up of several state and federal agencies -- was created in January 2012 to search for misconduct in the creation, packaging and sale of residential mortgage-backed securities. More than two dozen subpoenas were issued to banks and other industry players and West put out a public call for whistle-blowers and bank insiders to help.

Millions of documents poured in and specific matters were farmed out to about 10 U.S. attorney offices.

The department, using its own funds and some from the Federal Housing Finance Agency inspector general’s office, went on a hiring spree. Two dozen support staff, such as financial analysts and investigators, were brought on, along with 10 prosecutors and 85 contract attorneys, according to data provided by the department. An additional 15 contract attorneys were hired for the office of Schneiderman, who is co-chairman of the RMBS group.

Federal resources, including 11 assistant U.S. attorneys, helped Schneiderman sue JPMorgan over Bear Stearns mortgage bonds in October 2012, according to department data. Schneiderman, who said when the case was filed that it would be a template for future cases against issuers of mortgage-backed securities, said in a statement that the case is among those being negotiated in the department’s deal.

SEC Deals

The group also had a hand in $417 million in settlements that the U.S. Securities and Exchange Commission reached with JPMorgan and Credit Suisse Group AG (CSGN) over RMBS sales a month later.

The probes picked up speed and a sense of urgency this spring as West brought in his counsel, Geoffrey Graber, to direct the effort, he said. Graber had just wrapped up getting the government’s lawsuit against McGraw-Hill Cos. and its Standard & Poor’s unit filed in California, alleging the companies knowingly understated the credit risks of bonds and derivatives.

That case wasn’t the product of the working group -- resulting instead from an investigation that lasted three years. It was, however, premised on the same law being used by the working group in its probes.

FIRREA

The law, the Financial Institution Reform, Recovery and Enforcement Act of 1989, known as FIRREA, is a remnant of the savings-and-loan crisis of the 1980s. It allows the government to sue an individual or group, rather than charge them with a crime, for fraud that affects a federally insured financial institution.

FIRREA carries a 10-year statute of limitations, giving the government double the time to bring its case than allowed under other securities laws.

Other advantages of FIRREA include a lower burden of proof than what is needed to win a criminal case as well as prosecutor access to secret grand-jury evidence that may have been developed in the course of separate criminal probes.

The U.S. can extract hefty penalties as well. FIRREA allows penalties of more than $1 million for each fraudulent statement or act, and as much as $5 million for continuing violations of underlying criminal statutes.

Using bank and industry insiders, members of the group identified who the key players were, the relationships between different entities and patterns of conduct and similarities among the various probes, West said.

‘Same Pattern’

“Understanding how the RMBS process worked from insider perspective was very important,” West said. “Once you began to get information about how something worked you could then look at other cases you were doing and if you saw that same pattern it really helped you begin to unravel some complexities involved in those cases.”

Earlier this year, Holder said he instructed the RMBS group to identify the most promising leads and direct personnel and funds to those matters. A set of possible cases were identified and deadlines for completing those matters were set. Prosecutors from less-promising cases were moved to those on the priority list.

Focus Attention

“It was all with the thought that we needed to really focus our attention, focus our efforts, so that we could get to the results that would have a deterrent effect, would hold people and institutions accountable and do it as quickly as we could,” Holder said.

Holder held meetings in his conference room every two weeks with West, Graber and Michael Bresnick, who until August had been executive director of Obama’s Financial Fraud Enforcement Task Force, and others. A printout would be given to Holder that included all the cases under review with the current status of each probe along with a column for comments, he said. Calls were made to the U.S. attorneys managing the probes.

“Knowing you’re going to be speaking to the attorney general tends to keep people on task and on focus,” Holder said.